Origins of the Balanced Scorecard The Balanced Scorecard was developed by two men. Robert Kaplan a professor at Harvard University and David Norton a consultant also from the Boston area. In 1990. Kaplan and Norton led a research study of a dozen companies exploring new methods of performance measurement. The impetus for the study was a growing belief that financial measures of performance were ineffective for the modern business enterprise. The study companies along with Kaplan and Norton were convinced that a reliance on financial measures of performance was affecting their ability tocreate value. The group discussed a number of possible alternatives but settled on the idea of a Scorecard featuring performance measures capturing activities from throughout the organization—customer issues internal business processes employee activities and of course shareholder concerns. Kaplan and Norton labeled this new tool the Balanced Scorecard and later summarized the concept in the first of three Harvard Business Review articles. “The Balanced Scorecard—Measures that Drive Performance.” Over the next four years a number of organizations adopted the Balanced Scorecard and achieved immediate results. Kaplan and Norton discovered that these organizations were not only using the Scorecard to complement financial measures with the drivers of future performance but were also communicating their strategies through the measures they selected for their Balanced Scorecard. As the Scorecard gained prominence with organizations around the globe as a key tool in the implementation of strategy. Kaplan and Norton summarized the concept and the learning to that point in their 1996 book The Balanced Scorecard. Performance Measurement and the Need for a Balanced Scorecard Since that time the Balanced Scorecard has been adopted by nearly half of the Fortune 1000 organizations and the momentum continues unabated. Once considered the exclusive domain of the for-profit world the Balanced Scorecard has been translated and effectively implemented in both the notfor- profit and public sectors. These organizations have learned that by slightly modifying the Scorecard framework they are able to demonstrate to their constituents the value they provide and the steps they are taking to fulfill their important missions. Chapter Thirteen will take a closer look at how the Balanced Scorecard is being successfully implemented in both the public and not-for-profit sectors. So widely accepted and effective has the Scorecard been that the Harvard Business Review recently hailed it as one of the 75 most influential ideas of the twentieth century. Does all this whet your appetite for more? Let’s now turn our attention to the tool itself and see what makes up the Balanced Scorecard. What Is a Balanced Scorecard?We can describe the Balanced Scorecard as a carefully selected set of measures derived from an organization’s strategy. The measures selected for the Scorecard represent a tool for leaders to use in communicating to employees and external stakeholders the outcomes and performance drivers by which the organization will achieve its mission and strategic objectives. A simple definition however cannot tell us everything about the Balanced Scorecard. In my work with many organizations and research into best practices of Scorecard use. I see this tool as three things: measurement system strategic management system and communication tool. Let’s take a look at each of these Scorecard uses. The Balanced Scorecard as a Measurement System
Earlier in the chapter we discussed the limiting features of financial performance measures. While they provide an excellent review of what has happened in the past they are inadequate in addressing the real value-creating mechanisms in today’s organization—the intangible assets such as knowledge and networks of relationships. We might call financial measures lag indicators. They are outcomes of actions previously taken. The Balanced Scorecard complements these lag indicators with the drivers of future economic performance or lead indicators. But from where are these performance measures (both lag and lead) derived? The answer is your strategy. All the measures on the Balanced Scorecard serve as translations of the organization’s strategy. What is striking about this diagram is that vision and strategy are at the center of the Balanced Scorecard system not financial controls as in many organizations. Many organizations have inspiring visions and compelling strategies but are often unable to use those beautifully crafted words to align employee actions with the firm’s strategic direction. I Peter Senge describes this dilemma when he notes. “Many leaders have personal visions that never get translated into shared visions that galvanize an organization.” The Balanced Scorecard allows an organization to translate its vision and strategies by providing a new framework one that tells the story of the organization’s strategy through the objectives and measures chosen. Rather than focusing on financial control devices that provide little in the way of guidance for long-term employee decision making the Scorecard uses measurement as a new language to describe the key elements in the achievement of the strategy. The use of measurement is critical to the achievement of strategy. In his book Making Strategy Work. Timothy Galpin notes “measurable goals and objectives”11 as one of the key success factors of making strategy work. While the Scorecard retains financial measures it complements them with three other distinct perspectives: Customer. Internal Processes and Learning and Growth. PerspectivesIn this section of the chapter we will examine each of the four perspectives of the Balanced Scorecard. The use of the word perspective is intentional and I believe represents the preferred method when discussing the Scorecard. You may hear others refer to the four “quadrants” instead of perspectives. The Oxford dictionary begins its definition of the word quadrant by describing it as a quarter of circle’s circumference. The word reflects the number four and in that sense is almost limiting to the flexible approach inherent in the Scorecard. You may wish to have five perspectives or only three. Stick to the word perspective as it is more generic and merely reflects a viewpoint not a fixed number. Customer PerspectiveWhen choosing measures for the Customer perspective of the Scorecard organizations must answer two critical questions: Who are our target customers? and What is our value proposition in serving them? Sounds simple enough but both of these questions offer many challenges to organizations. Most organizations will state that they do in fact have a target customer audience yet their actions reveal an “all things to all customers” strategy. As we learned from Michael Porter earlier in the chapter this lack of focus will prevent an organization from differentiating itself from competitors. Choosing an appropriate value proposition poses no less of a challenge to most firms. Many will choose one of three “disciplines” articulated by Treacy and Wiersema in The Discipline of Market Leaders:• Operational Excellence. Organizations pursuing an operational excellence discipline focus on low price convenience and often “no frills.” Wal-Mart provides a great representation of an operationally excellent company.• Product Leadership. Product leaders push the envelope of their firm’s products. Constantly innovating they strive to offer simply the best product in the market. Nike is an example of a product leader in the field of athletic footwear.• Customer Intimacy. Doing whatever it takes to provide solutions for unique customers’ needs help define the customer intimate company. They do not look for one-time transactions but instead focus on long-term relationship building through their deep knowledge of customer needs. In the retail industry Nordstrom epitomizes the customer intimate organization. Regardless of the value discipline chosen this perspective will normally include measures widely used today: customer satisfaction customer loyalty market share and customer acquisition for example. Equally as important the organization must develop the performance drivers that will lead to improvement in these “lag” indicators of customer success. In Chapter Five we will take a closer look at the Customer perspective and identify what specific steps your organization should take to develop Customer measures. Internal Process PerspectiveIn the Internal Process perspective of the Scorecard we identify the key processes the firm must excel at in order to continue adding value for customers and ultimately shareholders. Each of the customer disciplines outlined above will entail the efficient operation of specific internal processes in order to serve the firm’s customers and fulfill the firm’s value proposition. Our task in this perspective is to identify those processes and develop the best possible measures with which to track our progress. To satisfy customer and shareholder expectations you may have to identify entirely new internal processes rather than focusing your efforts on the incremental improvement of existing activities. Product development production manufacturing delivery and postsale service may be represented in this perspective. Many organizations rely heavily on supplier relationships and other thirdparty arrangements to effectively serve customers. In those cases you might consider developing measures in the Internal Process perspective to represent the critical elements of those relationships. The development of performance measures for Internal Processes will be examined in greater depth in Chapter Five. Learning and Growth PerspectiveIf you want to achieve ambitious results for internal processes customers and ultimately shareholders where are these gains found? The measures in the Learning and Growth perspective of the Balanced Scorecard are really the enablers of the other three perspectives. In essence they are the foundation on which this entire house of a Balanced Scorecard is built. Once you identify measures and related initiatives in your Customer and Internal Process perspectives you can be certain of discovering some gaps between your current organizational infrastructure of employee skills and information systems and the level necessary to achieve your results. The measures you design in this perspective will help you close that gap and ensure sustainable performance for the future. Like the other perspectives of the Scorecard we would expect a mix of core outcome (lag) measures and performance drivers (lead measures) to represent the Learning and Growth perspective. Employee skills employee satisfaction availability of information and alignment could all have a place here. Many organizations struggle in the development of learning and growth measures. It is normally the last perspective to be developed and perhaps the teams are intellectually drained from their earlier efforts of developing new strategic measures or they simply consider this perspective “soft stuff” best left to the Human Resources group. No matter how valid the rationale seems this perspective cannot be overlooked in the development process. As mentioned earlier the measures developed in the Learning and Growth perspective are really the enablers of all other measures on the Scorecard. Think of them as the roots of a tree that will ultimately lead through the trunk of internal processes to the branches of customer results and finally to the leaves of financial returns. We will return to this important topic in Chapter Five. Financial MeasuresFinancial measures are an important component of the Balanced Scorecard especially in the for-profit world. The measures in this perspective tell us whether our strategy execution which is detailed through measures chosen in the other perspectives is leading to improved bottom-line results. We could focus all of our energy and capabilities on improving customer satisfaction quality on-time delivery or any number of things but without an indication of their effect on the organization’s financial returns they are of limited value. Classic lagging indicators are normally encountered in the Financial perspective. Typical examples include profitability revenue growth and economic value added. As with the other three perspectives we will return to have another look at financial measures in Chapter Five. The Balanced Scorecard as a Strategic Management System For many organizations the Balanced Scorecard has evolved from a measurement tool to what Kaplan and Norton have described as a “strategic management system.” While the original intent of the Scorecard system was to balance historical financial numbers with the drivers of future value for the firm as more and more organizations experimented with the concept they found it to be a critical tool in aligning short-term actions with their strategy. Used in this way the Scorecard alleviates many of the issues of effective strategy implementation we discussed earlier in the chapter. Let’s revisit those barriers and examine how the Balanced Scorecard may in fact remove them. Overcoming the Vision Barrier through the Translation of StrategyThe Balanced Scorecard is ideally created through a shared understanding and translation of the organization’s strategy into objectives measures targets and initiatives in each of the four Scorecard perspectives. The translation of vision and strategy forces the executive team to specifically determine what is meant by often vague and nebulous terms contained in vision and strategy statements for example best in class superior service and targeted customers. Through the process of developing the Scorecard an executive group may determine that superior service means 95 percent on-time delivery to customers. All employees can now focus their energies and day-today activities toward the crystal-clear goal of on-time delivery rather than wondering about and debating the definition of superior service. Using the Balanced Scorecard as a framework for translating the strategy these organizations create a new language of measurement that serves to guide all employees’ actions toward the achievement of the stated direction. Cascading the Scorecard Overcomes the People BarrierTo successfully implement any strategy it must be understood and acted on by every level of the firm. Cascading the Scorecard means driving it down into the organization and giving all employees the opportunity to demonstrate how their day-to-day activities contribute to the company’s strategy. All organizational levels distinguish their value creating activities by developing Scorecards that link to the high-level corporate objectives. Cascading creates a line of sight from the employee on the shop floor back to the executive boardroom. Some organizations have taken cascading all the way down to the individual level with employees developing personal Balanced Scorecards that define the contribution they will make to their team in helping it achieve overall objectives. Chapter Eight will take a closer look at the topic ofcascading and discuss how you can develop aligned Scorecards throughout your organization. Rather than linking incentives and rewards to the achievement of shortterm financial targets managers using the Balanced Scorecard have the opportunity to tie their team’s department’s or business unit’s rewards directly to the areas in which they exert influence. All employees can now focus on the performance drivers of future economic value and what decisions and actions are necessary to achieve those outcomes. Chapter Ten will outline strategies for the linkage of Balanced Scorecard results to compensation. Strategic Resource Allocation Overcomes the Resource BarrierWhen discussing this barrier we noted that most companies have separate processes for budgeting and strategic planning. Developing your Balanced Scorecard provides an excellent opportunity to tie these important processes together. When we create a Balanced Scorecard we not only think in terms of objectives measures and targets for each of our four perspectives but just as critically we must consider the initiatives or action plans we will put in place to meet our Scorecard targets. If we create long-term stretch targets for our measures we can then consider the incremental steps along the path to their achievement. The human and financial resources necessary to achieve Scorecard targets should form the basis for the development of the annual budgeting process. No longer will departments and business units submit budget requests that simply take last year’s amount and add an arbitrary 5 percent. Instead the necessary costs (and profits) associated with Balanced Scorecard targets are clearly articulated in their submission documents. This enhances executive learning about the strategy as the group is now forced (unless they have unlimited means) to make tough choices and trade-offs regarding which initiatives to fund and which to defer. The building of a Balanced Scorecard also affords you a great opportunity to critically examine the current myriad initiatives taking place in your organization. As a consultant when I visit a new client one of the laments I hear repeatedly from front-line employees is. “Oh no another new initiative!” Many executives have pet projects and agendas they hope to advance often with little thought of the strategic significance of such endeavors. More worrisome is the potential for initiatives from different functional areas to work against one another. Your Marketing department may be attempting to win new business through an aggressive marketing campaign while independently your Human Resources group has just launched a new incentive program rewarding the Sales staff for repeat business with existing customers. Should the Sales team focus on winning new customers or nurturing current relationships? Initiatives at every level of the organization and from every functional area must share one common trait: a linkage to the firm’s overall strategic goals. The Balanced Scorecard provides the lens for making this examination. Once you have developed your Scorecard you should review all the initiatives currently underway in your organization and determine which are truly critical to the fulfillment of your strategy and which are merely consuming valuable and scarce resources. Obviously the resource savings are beneficial but more importantly you signal to everyone in the organization the critical factors for success and the steps you are taking to achieve them. Chapter Nine is devoted to a greater review of this topic and provides guidance on how you can link your budgets to strategy. Strategic LearningOvercomes the Management BarrierIn the rapidly changing business environment most of us face we need more than an analysis of actual versus budget variances to make strategic decisions. Unfortunately many management teams spend their precious time together discussing variances and looking for ways to correct these “defects.” The Balanced Scorecard provides us with the necessary elements to move away from this paradigm to a new model in which Scorecard results become a starting point for reviewing questioning and learning about our strategy. The Balanced Scorecard translates our vision and strategy into a coherent set of measures in four balanced perspectives. Immediately we have more information to consider than merely financial data. The results of our Scorecard performance measures when viewed as a coherent whole represent the articulation of our strategy to that point and form the basis for questioning whether our results are leading us any closer to the achievement of that strategy. As seen in the next section any strategy we pursue represents a hypothesis or our best guess of how to achieve success. To prove meaningful the measures on our Scorecard must link together to tell the story of or describe that strategy. If for example we believe an investment in employee training will lead to speedier product development cycles we need to test that hypothesis through the measures appearing on our Scorecard. If employee training increases to meet our target but product development has actually slowed then perhaps that is not a valid assumption and we should be focusing on improving employee access to key information. It may take considerable time to gather sufficient data to test such correlations but simply having managers begin to question the assumptions underlying the strategy is a major improvement over making decisions based purely on financial numbers. The Balanced Scorecard as a Communication ToolThe preceding sections have discussed the use of the Balanced Scorecard as a pure measurement system and its evolution into a Strategic Management System. There was considerable discussion about the power of the Scorecard in translating the strategy and telling its story to all employees— what might be called communicating. So why is an entire section (albeit a short one) necessary to outline why the Balanced Scorecard should be considered a communication tool? Simply because it is the most basic and powerful attribute of the entire system. A well-constructed Scorecard eloquently describes your strategy and makes the vague and imprecise world of visions and strategies come alive through the clear and objective performance measures you have chosen. Much has been written in recent years about knowledge management strategies within organizations and many schools of thought exist. One common trait of all such systems may be the desire to make the implicit knowledge held within the minds of your workforce explicit and open for discussion and learning. We live in the era of the knowledge worker—the employee who unlike his organizational descendents who relied on the physical assets of the company owns the means of production: knowledge. There may be no greater challenge facing your organization today than codifying and acting on that knowledge. In fact. Peter Drucker has called managing knowledge worker productivity one of the great management challenges of the twenty-first century. Sharing Scorecard results throughout the organization provides employees with the opportunity to discuss the assumptions underlying the strategy learn from any unexpected results and dialogue on future modifications as necessary. Simply understanding the firm’s strategies can unlock many hidden organizational capacities as employees perhaps for the first time know where the organization is headed and how they can contribute during the journey. One organization I worked with conducted employee surveys before and after the development of the Balanced Scorecard. Prior to implementation less than 50 percent said they were aware of and understood the strategy. One year following a full Bal anced Scorecard implementation that number had risen to 87 percent! If you believe in openly disseminating information to your employees practicing what some would call “open book management,” then there is no better tool than the Balanced Scorecard to serve as your open book. The Importance of Cause and EffectIf this book is your first introduction to the Balanced Scorecard concept you may be saying to yourself. “We have lots of nonfinancial information: customer satisfaction quality statistics and employee morale data. I guess we’re well on our way to the Balanced Scorecard.” Not so fast! What really separates the Balanced Scorecard from other performance management systems is the notion of cause and effect. The best strategy ever conceived is simply a hypothesis developed by the authors. It represents their best guess as to an appropriate course of action given their knowledge of information concerning the environment competencies competitive positions and so on. What is needed is a method to document and test the assumptions inherent in the strategy. The Balanced Scorecard allows us to do just that. A well-designed Balanced Scorecard should describe your strategy through the objectives and measures you have chosen. These measures should link together in a chain of cause-and-effect relationships from the performance drivers in the Learning and Growth perspective all the way through to improved financial performance as reflected in the Financial perspective. We are attempting to document our strategy through measurement making the relationships between the measures explicit so they can be monitored managed and validated. Here is a typical example of cause and effect: Let’s say your organization would like to pursue a growth strategy. You therefore determine that you will measure revenue growth in the Financial perspective of the Scorecard. You hypothesize that loyal customers providing repeat business will result in greater revenues so you measure customer loyalty in the Customer perspective. How will you achieve superior levels of customer loyalty? Now you must ask yourself what internal processes the organization must excel at in order to drive customer loyalty and ultimately increase revenue. You believe customer loyalty is driven by your ability to continuously innovate and bring new products to the market and therefore you decide to measure new product development cycle times in the Internal Process perspective. Finally you have to determine how you will improve cycle times. Investing in employee training on new development initiatives may eventually lower development cycle time and is then measured under the Learning and Growth perspective of the Balanced Scorecard. This linkage of measures throughout the Balanced Scorecard is constructed with a series of “if–then” statements: If we increase training then cycle times will lower. If cycle times lower then loyalty will increase. If loyalty increases then revenue will increase. When considering the linkage between measures we should also attempt to document the timing and extent of the correlations. For example do we expect customer loyalty to double in the first year as a result of our focus on lowering new product development cycle times? Explicitly stating the assumptions in our measure architecture makes the Balanced Scorecard a formidable tool for strategic learning. Creating the cause-and-effect linkages between performance measures can prove to be the most challenging aspect of a Balanced Scorecard implementation. However as with most endeavors the ultimate reward is worth the hard work since you will now have more than an ad-hoc collection of financial and nonfinancial measures. Instead you will have developed a system that articulates your strategy serves to communicate that strategy to all employees and allows for ongoing strategic learning as you test and validate your model. We will return to this important topic in Chapter Six. Balance in the Balanced ScorecardAs you develop the Balanced Scorecard in your organization you may encounter some resistance to the actual term Balanced Scorecard itself. Some may believe the Balanced Scorecard represents the latest management fad sweeping executive suites around the nation and the mere mention of such a buzzword would preclude employees from accepting the tool regardless of its efficacy. This may represent a legitimate concern depending on the fate of previous change initiatives within your organization. Others may prefer Performance Management System. Scoreboard or any number of monikers for the tool. It is important to consistently use the term Balanced Scorecard when describing this tool. The concept of balance is central to this system specifically relating to three areas:1. Balance between financial and nonfinancial indicators of success. The Balanced Scorecard was originally conceived to overcome the deficiencies of a reliance on financial measures of performance by balancing them with the drivers of future performance. This remains a principal tenet of thesystem.2. Balance between internal and external constituents of the organization. Shareholders and customers represent the external constituents expressed in the Balanced Scorecard while employees and internal processes represent internal constituents. The Balanced Scorecard recognizes the importance of balancing the occasionally contradictory needs of all these groups in effectively implementing strategy.3. Balance between lag and lead indicators of performance. Lag indicators generally represent past performance. Typical examples might include customer satisfaction or revenue. Although these measures are usually quite objective and accessible they normally lack any predictive power. Lead indicators are the performance drivers that lead to the achievement of the lag indicators. They often include the measurement of processes and activities. On-time delivery might represent a leading indicator for the lagging measure of customer satisfaction. While these measures are normally thought to be predictive in nature the correlations may prove subjective and the data difficult to gather. A Scorecard should include a mix of lead and lag indicators. Lag indicators without leading measures do not communicate how targets will be achieved. Conversely leading indicators without lag measures may demonstrate short-term improvements but don’t show whether these improvements have led to improved results for customers and ultimately shareholders.
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